Canada’s housing market flirts with bubble

After a brief dip, home prices have shot up; incomes haven’t kept up

WarangkanaChomchuen

A Toronto home for sale. Ontario home prices have jumped roughly 30% since their crisis troughs, lending to worries about a Canadian housing bubble.

NEW YORK (MarketWatch) — Rising home prices over the past decade, combined with mounting household debts, have fed concerns that Canada’s housing market has formed a bubble that’s about to burst.

“We call it a tug of war,” said Sonya Gulati, economist in regional economies, housing and government finance at TD Economics, an affiliate of Toronto-Dominion Bank. “Low interest rates make people want to participate in the housing market, but with modest growth, not strong job creation, we can see a negative repercussion on the horizon.”

A crash, or even sharp retreat, in home prices would contrast to the resilience of Canada’s housing market during the economic downturn, particularly compared to its U.S. counterpart.

Average American home prices have plunged 34% from their peak in April 2006 as of the most recent reading in December. In Canada, national average house prices fell 9% from their peak in August 2008 before they bottomed in April 2009, separate indexes from Teranet-National Bank of Canada and S&P/Case-Shiller show.

The U.S. housing market has recently started to improve, but it’s still far from prerecession levels. Sales of U.S. existing homes rose 4.3% in January, reaching the highest pace since May 2010, the National Association of Realtors said. However, American home prices in December fell to their lowest level since the housing crisis. Read more on U.S. home sales.

Relaxed lending standards in the U.S. and a Federal Reserve policy that kept interest rates at 1% for a full year before the central bank started to gradually raise them were blamed for the rapid gains in U.S. home prices until their peak in 2006, pushing values to unsustainable highs.

Canada discouraged overborrowing and limited its banks’ exposure to subprime lending with more conservative regulations and lending standards. Borrowers had to show employment and income records to take loans, while Canadian mortgage rates were kept higher than the U.S. rates over the same period to avoid boom-time price increases.

Canadians pile on debt

Canadian homeowners weren’t immune from the global financial crisis. But after home prices started to recover three years ago, Canadians have seen a sharp run-up in house prices relative to income, as well as excess real-estate inventories. Their bank accounts show a historic high debt-to-income ratio, spurred by ultralow interest rates.

The Bank of Canada announced on Thursday it would maintain its interest rate at 1%, which the central bank has kept steady since September 2010.

House prices in Canada have doubled in the past decade, with double-digit growth in the past few years. In British Columbia and Ontario, for instance, prices grew by 41% and 29% since their crisis troughs in the past few years, according to a 2011 country report on Canada by the International Monetary Fund.

Alongside these gains, Canadian homeowners have become more debt-strapped. The level of household debt relative to disposable income has accelerated to 153% in 2011, versus 110% in 1999, Statistics Canada said.

These levels bear an eerie similarity to U.S. households’ debt burden before the financial crisis. The U.S. debt-to-income ratio climbed to its peak at 130% in the third quarter of 2007, according to the Federal Reserve’s Flow of Funds report. Much of the sluggish U.S. economic recovery has been blamed on a massive deleveraging by these debt-strapped consumers.

Though not a perfect metric, the rising trend in the debt-to-income ratio “flags the fact that Canadians are becoming more leveraged and are more vulnerable to an economic shock than they were heading into to 2008/2009 recession,” Craig Alexander, chief economist at TD Bank, said in a report.

“Housing contributed positively to the boom years and it will have a negative impact on broader economy when the market unwinds,” said David Madani, Canada economist at Capital Economics.

Supply glut

Immigration and population growth in Canada, which has grown 5.9% from 2006 to 2011, help drive housing demands. But the population growth in some cities can no longer keep up with real-estate inventories.

The greater Toronto area has experienced a boom in high-rise condominiums in recent years. Housing starts are approximately 40,000 per year, exceeding the demographic need of about 18,000 to 25,000 units, Gulati, of TD Economics, said.

“The number is not going to be sustained,” Gulati said. “There’s going to be a gradual unwinding of excess in the next few years. The competition between new and resale markets will lead to a negative repercussion in terms of price.”

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